June 13, 2010 More Fiscal Cracks

Economy:

Underfunded pension plans are not new to our long-time readers. Problems began surfacing after the tech bubble burst last decade. All but the politicians recognize the absence of money in the Social Security “trust fund.” Now, state pension unfunded liabilities are starting to show up in municipality downgraded credit scores.

How are these and other states going to solve their financial woes? Last year’s federal stimulus bill financed a good dose of political procrastination. Yet, the federal government, i.e., you and me taxpayer, will be the piggy bank of first choice.

However, the U.S. domestic debt is in dangerous territory of 90%+ debt to GDP. Our deficit is running at 10% of GDP. We are refusing to look at either Japan or socialized Europe for lessons from history. The Administration is backstopping virtually anything it deems “too big to fail.” Is “too big to fail” contagious? We will soon find out as Great Britain deals with BP’s possible bankruptcy.

Last week we reviewed the unemployment report. The stimulus has either failed or had nominal impact. Yet, the massive debt it incurred remains. Another jobs bill will not be a catalyst for a turn-around, but it will increase our national debt.

How much debt is too much? There is no way to know until Japan and China just quit buying it. One day they are bidders. The next day, they aren’t.

That is what happened with Greece. No bidders.

The European Central Bank forced a solution, but not over concerns for Greece. French banks, the largest holders of Greek bonds, would have been jeopardized if Greece defaulted on its debt. Germany is the second largest creditor to Greece. Under the fear of a domino effect, the ECB cobbled together a band-aid which, when approved, Greece began talks to renegotiate the austerity measures. How committed is that to real change?

Australia seems to be the only Western Economy that has dealt responsibly with expansion of its debt and reduced incentives for household leverage by systematically raising interest rates during a period of growth. Unemployment remains low in Australia. Gordon Stevens, head of Australia’s central bank, expects little impact on Aussies from the European mess. Consider these excerpts from his speech on Wednesday.

1. "However well households have coped with the events of recent years, further big increases in indebtedness could increase their vulnerability to shocks - such as a fall in income - to a greater extent than would be prudent."
2. "Australia's budgetary position is very different from those in Europe and, for that matter, most countries"
3. "Public debt is low and budget deficits are under control and already scheduled to decline."

How long will it be before our Fed Chairman can make that report?

Real Estate:

Mortgage applications have dropped significantly with the end of tax credits for home buyers. Shazaam! Imagine that! A recent conference call with Toll Brothers, a large luxury home builder, admitted buyer traffic was down 2/3rds from April to May.

Small builders are banding together to have the Federal government provide guarantees because loans aren’t available through normal lending channels. Is there any end to those lining up for a “bail-out?” This is not the making of a rebounding economy. Buyers are required and remain in short supply.

Stock Market:

In the long run, earnings matter. Arthur Laffer recently opined that this year’s strong corporate earnings are due to income shifting by companies who are doing what they can to avoid next year’s significant tax increases. Individuals doing the same thing result in domestic GDP growth being overstated. He expects the market to anticipate a decline in GDP resulting in another recession near year’s end.

An old joke is that economist have predicted five of the last two recessions. It is no surprise that there are some economists who disagree with Mr. Laffer. In a WSJ editorial that did not completely disagree, corporate earnings improvements were attributed to high unemployment and associated increases in productivity. People who do not want to lose their job, apparently, work harder. This has allowed for some increase in year over year wages resulting in some forecasts to dismiss the impending recession scenario.

While European countries have announced austerity plans, a strong political commitment to implementation has not been evident. If this continues, impact on slowing global growth will be delayed for another round of politicians. Japan’s new PM seems to be committed to slowing government’s growth and retiring its massive debt. China has announced plans to stop real estate speculation without which entire cities would not have been built. Last month, home prices fell 60% to 70% in some provinces. That’s serious and seems like a negative, to us, for global GDP.

Our relative strength portfolios remain bearish. We continue to monitoring the market waiting for an appropriate signal to move back into equity markets. The markets continue to be very volatile and a discernable upward trend has yet to form. We anticipate remaining defensive for the near term.

Investor Resources, Inc. is a registered investment adviser in the States of Washington, Arizona and Texas. The adviser may not transact business in states where it is not appropriately registered, excluded or exempted from registration. Individualized responses to persons that involve either the effecting of transaction in securities, or the rendering of personalized investment advice for compensation, will not be made without registration or exemption.